I have always interested to find out what makes a company tick. Why some companies succeed while others fail? What enables a company to grow continuously for decades when others fail to maintain that even for a few years. Is it management? The nature of the industry? The products a company offers? Or is it something else? Below are some essential readings that have built my knowledge on the fundamental of competitions. Understand the language of strategy is critical to improve your analytical thinking skill as an investor.
Strategic Logic by Jose Jarillo
The fundamental of competitive advantage is “a company can make money only if it is able to do something that the market wants and that its competitors cannot imitate; or if it is able to do the same things its competitors do, but more cheaply; or both.” How do we know if, when, and how such conditions exist? That is where strategic logic comes in. Strategic logic is more than analyzing different types of moats, but to understand how a company’s strategy and decisions such as whether to move into an adjacent market, integrate vertically, build or buy, and expand internationally, etc impact future profitability. Just as a simple decision like outsourcing an activity can spell success for a firm but trouble to another firm in a different industry, it is essential to understand the context, or logic, which these decisions are carried out.
Understanding Michael Porter by Joan Magretta
Joan Magretta’s book distills the essence of Michael Porter’s work on how to analyze competition and understand strategy. Two reasons why this book is important. We have a misconception about what strategy truly means. Some would think automation is a strategy but that is just operational efficiency. A business has to do it to survive. In contrast, a strategy is a choice; a tradeoff between what to do and what not to do. Another reason is overconfidence. We tend to overestimate the success of a company when we fail to take into account what the competitors are doing. You will learn about the 5 forces of competition, what creates competitive advantage, how business creates value, and how activities within a value chain form a company’s strategy.
Capital Returns by Edward Chancellor
A typical capital cycle looks like this: A company decides to reinvest all its earnings for aggressive expansion in order to meet strong demand growth. Fast-forward 5 years, the price has collapsed due to excess supply in the market, competitions from entrants, and little prospect of demand recovery due to a slow economy.
Instead of analyzing future demand growth which is inherently challenging, capital returns analyze the ebb and flow of capital to understand how changes in the amount of capital employed within an industry are likely to impact future returns. High demand growth tends to encourage excessive capital investment which eventually lead to oversupply situation and lower return. How does this apply to companies with moats? Moat companies have the ability to prevent supply overcapacity through barriers. Therefore, ensuring a consistently high return.
Competitive Demystified by Bruce Greenwald
Strategies are more than just increasing profit margin and make more money, but “plans that specifically focus on the actions and responses of competitors.” Growth and profitability are not enough because competition always acts as a balancing feedback loop to counter that. The core of strategies is about “creating, protecting, and exploiting competitive advantages.” Bruce Greenwald cuts through the chest to answer the question of how companies can manage competitions and fend off potential entrants by creating strategies that allow them to capture most of the profit.
7 Powers by Hamilton Helmer
Hamilton Helmer identifies 7 types of powers a business can acquire to earn above average return. These powers are like moats, they create a powerful barrier that prevents competitors from competing effectively while allowing the business to earn an abnormal return. Unlike the usual book that describe the characteristics of each power, Helmer dive into how each power arises along the life cycle of a company, the benefit, and barrier created by these powers, as well as the determinant of power intensity.
The Little Book that Builds Wealth by Pat Dorsey
Companies that can create long-term wealth are often ones that can generate above-average profits. But most companies fail to do that consistently in the long run because above-average profits attract competition. Competition erodes profitability. However, some companies have managed to fend-off competition by building a barrier around their business. Commonly referred to as “moats”, these barriers are structural characteristics of a business that makes it hard for competitors to replicate. In this little book, Pat Dorsey uses real company examples to show how these moats deter competitors, as well as some common pitfalls investors should avoid such as overpaying for a stock. If you’re interested in finding and owning quality companies, this is a book for you.
Originally published at https://musingzebra.com on March 29, 2019.